Use of Annuities as a Medicaid Planning Tool in Colorado

The state regulations on treatment of annuities are found in Section 8.110.55 & 8.110.56, Volume 8 of the Colorado Department of Health Care Policy and Financing Medicaid Staff Manual, 10 C.C.R. 2505-10. In that section, an annuity is now defined as:

“. . . a contract between and individual and a commercial company, in which the individual invests funds

and in return is guaranteed fixed substantially equal installments for life or a specified number of years.”

Under Colorado Medicaid regulations, once an annuity has been annuitized and the annuitant is receiving regular distributions, the annuity is no longer considered as part of the asset pool for purposes of determining Medicaid eligibility. Instead, the monthly distributions are considered income to the annuitant in the month received.

Prior to the enactment of the current annuity regulations, which became effective on April 1, 1998, annuities could be used with relative safety in Medicaid estate planning in Colorado as a means of spending down countable assets and converting them into income for eligibility purposes. This method had been particularly useful in Medicaid planning for a married couple subject to the spousal impoverishment regulations.

The assets of both spouses are counted in determining the asset eligibility of the institutionalized spouse, while only the income of the institutionalized spouse is considered in determining income eligibility. By using assets of the married couple in excess of the CSRA to purchase an annuity which was then annuitized with payments going to the community spouse, the couple was able to spend down their assets without effecting the income eligibility of the institutionalized spouse. Meanwhile, the community spouse was allowed to continue enjoying the benefit of the former asset in the form of increased monthly income.

While the enactment of new regulations in 1998 placed some restrictions on the use of annuities purchased after April 1, 1998, it did not eliminate the use of annuities as an effective Medicaid planning tool for several reasons.

First, the 1998 regulations only affect annuities purchased after April 1, 1998. Annuities that were purchased prior to April 1, 1998 are still governed by the old regulations, whether or not they have already been annuitized. For an institutionalized spouse already on Medicaid, where the community spouse is receiving monthly payments from an annuity purchased and annuitized prior to April 1, 1998, the new regulations will not affect the institutionalized spouse’s continued eligibility for Medicaid benefits. Also, for an institutionalized spouse applying for Medicaid after April 1, 1998, an annuity purchased prior to that date can still be annuitized to reduce countable assets and the treatment of the resulting income to the community spouse will not be affected by the new regulations.

Second, even for couples who are only now planning for future Medicaid eligibility, the purchase of an annuity subject to the new regulations may still be a viable planning tool, depending on the circumstances.

The regulations governing treatment of annuities purchased prior to April 1, 1998 distinguish further between annuities purchased before or after July 1, 1995.

Any annuity purchased prior to July 1, 1995 by the applicant or the applicant’s spouse will be considered a countable resource to the Medicaid applicant only if it has not been annuitized. If the annuity is annuitized and the annuitant is receiving regular returns, the funds received will be considered income to the annuitant in the month received.

The only limitation imposed on annuities purchased before July 1, 1995 is that the annuity must meet the definition of “annuity”. That is, it must be: 1) a contract between and individual and a commercial company; 2) the annuity must provide a guaranteed income stream that is in fixed substantially equal installments (e.g., not a balloon or deferred lump sum annuity); and 3) the annuity period must be for life or a specified number of years.

For annuities purchase after July 1, 1995, the regulations provide four additional restrictions. If the annuity does not fit within all of the additional restrictions, the entire purchase price of the annuity is considered a transfer of assets without fair consideration and would trigger a period of ineligibility. In order to avoid the transfer penalty, the annuity must meet the following criteria, in addition to those applicable to annuities purchased prior to July 1, 1995:

1) The annuity must have been purchased from a life insurance company or other commercial company that sells annuities as part of its normal course of business;

2) The annuity must be annuitized for the applicant or the community spouse (although, for practical reasons, the community spouse would always be named as the annuitant);

3) The annuity must have been purchased on the life of the applicant or the community spouse; and

4) The annuity must provide payments for a period not to exceed the projected life of the annuitant (as determined by use of the appropriate life expectancy table -- male or female -- contained in the regulations).

Annuities purchased on or after April 1, 1998 are governed by the regulations which became effective on that date. The effect of these regulations is to impose limitations on the amount of assets in excess of the CSRA that can be converted into an annuitized income stream to the community spouse.

If annuitized regular payments from an annuity, purchased with assets in excess of the CSRA, cause the community spouse’s monthly income to exceed the MMMNA, a transfer penalty will be imposed. Also, if the monthly payments from the annuity are not “substantially equal” over the life of the annuity, as would be the case with a balloon or deferred lump sum annuity, the entire purchase price of the annuity will be considered a transfer for less than fair consideration and a penalty period will be imposed.

Any “transfers” which could be deemed to have taken place under the new regulations are subject to the 36 month look back period. That is, if the annuity was purchased more than 36 months prior to the filing of the Medicaid application, any penalty period will be treated as having expired. This means the monthly annuity payment, regardless of whether it causes the community spouse’s monthly income to exceed the MMMNA, will be treated as income in the month received.

The new regulations are troublesome. The MMMNA is typically not determined until a Medicaid application is filed for the institutionalized spouse. Since the MMMNA can range from the base amount (currently $1,561.25) up to a maximum MMMNA (currently $2,377.50), depending upon the existence and amount of excess shelter costs to the community spouse, the new regulation creates some uncertainty for planning purposes. If an annuity is purchased today, how much can it pay out without the community spouse’s monthly income exceeding the MMMNA that will be calculated for him or her upon the filing of a future Medicaid application? Unless the state Department can somehow be required to determine the MMMNA during the Medicaid planning period, an exact answer to this question cannot be provided. This leaves people in the process of Medicaid planning, to be on the safe side, in the position of having to base their annuity purchase decision on the base MMMNA then in effect.

Can the Department be required to make a pre-filing determination of the MMMNA? The new regulation states that “the county department shall determine the MMMNA of the community spouse”. However, the regulation does not say when. Presumably, this determination would continue to be made at the time of the filing of the Medicaid application for the institutionalized spouse. It is unclear whether the regulation would also permit a community spouse to demand a pre-filing determination of the MMMNA for Medicaid planning purposes. As a result, it is doubtful that the Department would honor such a demand, absent litigation and a court order requiring it.

In the Medicaid planning context, it will be necessary, as a practical matter, to assume a conservative application of the terms of the new regulation when the time comes. That is, projections of possible transfer penalties which may be triggered by annuity income will have to be based upon a presumption of the application of the minimum current MMMNA amount. This means that the projected benefit from purchase of an annuity will need to be measured against the fact that annuity payments up to the amount of the MMMNA will essentially represent a replacement of the MIA. Usually, this will still weigh in favor of an annuity purchase, since the source from which MIA will be paid, (e.g. institutionalized spouse’s pension), may not survive the death of the institutionalized spouse. An annuity will continue to pay out to the community spouse for the remainder of the annuity period, avoiding impoverishment of the community spouse upon the death of the institutionalized spouse. In addition, upon the death of the community spouse, the community spouse’s children can be designated to receive the balance of any annuity payments remaining. Thus, there are some advantages over merely relying on the MIA.

As a practical matter, any purchase of an annuity for Medicaid planning purposes will involve an expenditure of assets in excess of the CSRA. As a result, there will always be the potential for the imposition of a transfer penalty, depending on the effects on the community spouse’s income upon annuitization. Therefore, an essential part of the decision to purchase an annuity will now be the computation of the expected penalty period.

The regulation does not set forth the mathematical formula for calculating the penalty period, but it does provide that the transfer will consist of that portion of the monthly income in excess of the MMMNA which is caused by the purchase of the annuity from funds in excess of the CSRA. Knowing this, the formula, which can be deduced algebraically, is as follows:

For example: Assume that a couple has $140,760.00 in non-exempt assets. The community spouse’s total monthly income is her social security benefit of $750.00. Institutionalized spouse’s monthly income is less than $1,737.00, so that he is income qualified for Medicaid benefits. The couple needs to spend down $45,660.00 in order to reduce their total non-exempt assets to the CSRA of $95,100.00. If they purchase an annuity, the annuity payment over the annuity period (based upon the remaining life expectancy of the institutionalized spouse) will be $1,000.00 per month. The community spouse’s total income from social security and the annuity payment will be $1,750.00. The projected penalty period will be calculated as follows:

.11 x $45,660.00 = $5,022.60 (The amount transferred for less than fair consideration)

Since any penalty period would begin to run on the date the annuity is purchased (i.e. the date on which the transfer is made), the couple should wait 28 days before submitting a Medicaid application. If they wait out this period, no additional penalty period will be imposed. Since there will be a waiting period, the couple should be sure they have sufficient funds, if necessary, to pay privately for 28 days of nursing home care for the institutionalized spouse.

As you can see from the above example, the penalty period would be significantly less than that which would be imposed on an outright transfer of $45,66.00. (e.g. $45,660.00 ) $5,388 = 8.47 or 8 months and 15 days of ineligibility). The more that annuity income would raise the community spouse’s monthly income over the MMMNA, the longer the transfer penalty will be; and the closer the period of ineligibility would be to that resulting from an outright gift transfer (e.g. to the couple’s children) of the amount used to purchase the annuity. Therefore, the use of annuities would make the most sense in situations where the community spouse has a small monthly income.

If the annuity purchased does not cause the community spouse’s monthly income to exceed the MMMNA, there will be no transfer for less than fair consideration. Thus, in the above example, an annuity providing income of $901 or less per month would not result in any period of ineligibility. Also, if the annuity is purchased at a time when the couple’s assets do not exceed the CSRA, no penalty period will be imposed, regardless of the monthly income resulting. Finally, if a Medicaid application is not filed until 36 months after the purchase of the annuity (60 months if the annuity was purchased on or after February 8, 2006), there will be no transfer penalty, regardless of the amount of excess assets used to purchase the annuity or the amount of income which the annuity pays out.

As stated earlier, the 1998 change in the regulations does restrict the use of annuities purchased on or after April 1, 1998 as a Medicaid planning tool. However, in certain situations, the purchase of an annuity may still be an appropriate and advantageous planning tool. It is recommended that any couple considering the purchase of an annuity as part of their Medicaid planning consult with an experienced attorney before deciding whether or not to purchase an annuity.

[2] Average monthly cost of nursing home care in Colorado for 2007.

Treatment of Annuities Payable to the Medicaid Recipient and Purchased on or after February 8, 2006

As stated earlier, the above rule only applies where the annuitant is the Medicaid recipient's community spouse. Purchasing an annuity which will make monthly payments to the Medicaid recipient will not result in a transfer penalty, regardless of the size of the annuity payment, so long as the annuity meets the following criteria contained in the DRA:[i]

1. The annuity must have been purchased from a life insurance company or other commercial company that sells annuities as part of its normal course of business; and

2. The annuity must be annuitized to the Medicaid recipient; and

a. The annuity must be "actuarially sound," meaning it must be designed to pay out completely during the Medicaid recipient's remaining life expectancy (as determined by the appropriate life expectancy table -- male or female -- contained in the regulations); and

b. The annuity must make substantially equal payments over the entire period of the annuity; OR

c. The annuity is a qualified individual retirement annuity under IRC '408(b) or (q), or the annuity is purchased from a qualified individual retirement plan under IRC '408(a), (c), (p) or (k) or IRC '408A; and

5. The annuity must name the state as death beneficiary, at least up the amount of Medicaid benefits paid to annuitant. The state must be named as first death beneficiary unless the recipient has a spouse or a minor or disabled child, in which case that spouse or child may be named as first death beneficiary, with the state as second beneficiary if the spouse or child disposes of his or her remainder interest without fair consideration.

At first glance, it would seem futile to purchase such an annuity, since virtually all of the annuity payments after the Medicaid recipient enters the nursing home (or begins receiving long term care services at home) will be used to pay for long term care expenses. However, such an annuity could be a very effective planning tool whenever the Medicaid recipient makes gift transfers on or after February 8, 2006 to qualify for Medicaid.

The annuity would be purchased with all of the Medicaid recipient's excess resources remaining after completion of the recipient's "spend down" and other gift transfers (i.e., the hold-back amount in a "half loaf" gifting plan); and would be structured to pay out for a term not to exceed the penalty period from the transfers, or 60 months, whichever is shorter. Further, the monthly payments from the annuity would be designed to pay for the recipient's monthly long term care expenses in excess of the recipient's other income during the penalty period or look-back period. Finally, the annuity should not be annuitized until the recipient enters the nursing home or begins receiving long term care services at home.

Once annuitized, the annuity would no longer be countable as a resource and would not, by itself, delay the start of the penalty period once the Medicaid recipient is in a long term care setting and receiving services, since the recipient would have no more excess resources and would qualify for Medicaid, but for the transfers. The annuity payments could then provide for the Medicaid recipient's nursing home or other long term care expenses during the penalty period or look-back period. Once the annuity is exhausted and the penalty period or look-back period has expired, the recipient could begin receiving Medicaid long term care benefits in the nursing home or at home through HCBS.

Unfortunately, it can still be difficult to find commercial annuities fitting these requirements and which are available for a period certain of less than 18 months. Perhaps this will change if there is a great enough demand for a Medicaid-friendly annuity product of shorter duration. However, until a shorter term annuity product may become available, the use of an annuity to "bridge" the penalty period from gift transfers would usually not make sense unless the penalty period is approximately 18 months or more. Otherwise, a different strategy, such as a trust, reverse mortgage or long term care insurance, may be used.

[i] S. 1932, §6012(b) & (c).

WORKSHEET FOR CALCULATING PENALTY PERIOD FOR ANNUITIES PURCHASED ON OR AFTER APRIL 1, 1998

Mr. Campbell, the founder and principal attorney of the Law Offices of John J. Campbell, P.C., has practiced law for nineteen years and has concentrated in the practice of Elder Law since 1996; and is certified as an Elder Law Attorney by the National Elder Law Foundation.* Mr. Campbell is licensed to practice law in Colorado and is also licensed and on inactive status in Missouri. He is a member of the Colorado Bar Association, the Arapahoe County Bar Association, the Missouri Bar Association, the National Structured Settlements Trade Association, the National Alliance of Medicare Set-Aside Professionals and the National Academy of Elder Law Attorneys. Mr. Campbell has published numerous articles and has presented numerous seminars on issues relating to Elder Law across the country.

*The State of Colorado does not certify attorneys as experts in any field.